Chapter Six

The Pie Sours

Now let us examine the position in which the seller finds himself. Before he sold the property, it was indebted for $50,000 in the form of a first mortgage. Now there are three mortgages for a total of $67,500. In fact, it is mortgaged for more than the selling price of $62,500. The $7,500 mortgage belongs to the seller, so there are actually $60,000 owed ahead of his claim.

In the event that the buyer defaults on his payments of either or both of the first two mortgages, the seller, in order to protect his $7,500 third mortgage, must either assume or pay off the other two mortgages, which amount to $60,000.

If he is unable to handle the two mortgages, he will be out entirely. Thus all the seller would have recovered would be $5,000 from the payment of the first note by the buyer when he borrowed the $10,000. Remember the buyer appropriated the other $5,000 and now it must all be paid back.

I ask you is that any way to sell a property?

But the real estate lecturer is not looking out for the seller. So let us check the position of the buyers. We may find that their interests have been neglected also, in order to make a classroom story.

These presentations must be made quickly and leave little time for questions. It is amazing how many people will accept the lectures in their entirety as factual and not bother to check the presentations, if indeed they know how to do so.

In this particular case, I imagine what shines brightly in everyone's mind is a vision of a young couple having acquired a house and $5,000 in cash, with no investment on their part.

But, let us check the figures. From what I have seen thus far, I fear that they will paint a rather dismal picture.

Let us consider the $7,500 note first. I do so because the terms are stipulated. It has a 5-year life at 13% interest. Such a note would require a monthly payment of $170.66.

A second mortgage is usually a short-term instrument. It would be fair to give it a 5-year term. If the buyers agreed to pay 13% for the other loan, they probably did the same for this one. A $10,000 note for 5 years at 13% interest means a monthly payment of $227.54.

And now for the $50,000 first mortgage. Let us assume that it started out as $55,000 and was paid down to $50,000. It was probably a 25-year loan at 11% interest. At least the assumptions are reasonable. A $55,000 note for 25 years at 11% interest requires a monthly payment of $539.07.

The total amount necessary to amortize these three loans is $937.25. (Amortize means that payments are credited to both principal and interest, instead of interest alone.) Let us concede that taxes, insurance, upkeep and everything else to $400 per month.

Now the investment has put them in debt for $1,337.25 per month or $16,047 per year. It is doubtful if a $62,500 house could be rented for enough to cover these costs, let alone to show a profit.

I am sure it is obvious to you that the buyers could not possibly carry on with the staggering monthly payments and would find it necessary to default. The best that could happen to them, since their credit rating was reduced to zilch, would be to take their $5,000 and retire. However, they could be in real trouble in some states, where in the event of a foreclosure they could be held liable for the difference between the foreclosure sale price and the amount of the mortgages.

In this case, if a buyer were able to secure the foreclosure property for the amount of the first mortgage, or $50,000, which is often the case, the budding young couple would be liable for $17,500, which represents the other two mortgages. It seems reasonable to conclude that they are not headed towards a million-dollar real estate rating.

As I consider the above case, I am aware that at the present moment there are books, television and radio programs, lectures and other media expounding the same sort of concocted arithmetic as through which we have just waded. They are all being used as a source of income.

I have arrived at the conclusion that the measure of their success is directly proportionate to the extent to which the public can be cajoled into believing their stories. As a final gesture, I shall ask a few questions regarding the case at hand and you may furnish your own answers.

1. Does it seem reasonable that a property, which is actually worth $80,000 would be put on the market for $70,000?
2. Since the lecturer uses $80,000 as the value, do you suppose the seller would agree to accept $62,500?
3. If the seller did agree to accept $62,500, do you believe he would accept notes instead of cash?
4. If he agreed to accept two notes instead of cash, would his common sense permit the buyers to arrange a loan of unknown amount which would take precedence over his own $7,500 note?
5. The value of the place is not determined by what the lecturer declared it to be, but by the selling price, which was $62,500. In this case, a $10,000 loan along with the $50,000 first mortgage results in a 96% encumbrance. My question is, would anyone lend $10,000 under these hazardous circumstances?
6. If someone lent $10,000, what would be his attitude when he discovered the $7,500 mortgage, which resulted in a $67,500 indebtedness against a $62,500 property?
7. Since it was agreed the $7,500 mortgage could not be recorded until at least 60 days after close of escrow, and since escrow cannot be closed until everything has been recorded, do you see a problem?
8. In light of the above considerations, is it reasonable to expect that the owner of the first mortgage would allow it to be assumed?
9. Since the answers to all of my questions are obvious, I shall include one which may require a little thought. I admit that I don't know the answer. Let us assume that the deal was completed, as outlined in the real estate course. What did the young couple do with the $5,000 in cash which they skimmed off the top?
10. Has it occurred to you that the $5,000 was not free? As part of the $10,000 loan, it was schedule to be repaid over a period of five years at 13% interest which amounts to a monthly payment of $227.54.

These sorts of voodoo real estate deals have been presented to the public for many years. It is amazing how otherwise completely normal people subscribe to courses at several hundred dollars a throw and become overwhelmed by the dazzling possibilities set forth by certain ways of using simple arithmetic.

In these cases, what you see is not what you get. What you see might be compared to a beautiful girl in a store dressed in the latest, rather daring fashion, who attracted your attention while you were shopping. What you get is when you decide to walk over and try to engage her in conversation. You find that you have been admiring a mannequin.

Copyright ©1995 Robert A. MacDonald, All Rights Reserved.
Last revised: May 10, 1998.